What Is an AB Trust?

Once a person dies and their last will and testament is examined to begin the process of distributing assets among the beneficiaries, the estate may be subject to hefty taxes that could take a percentage of the assets before beneficiaries receive anything. An AB trust is one aspect of the estate plan that can help spouses maximize their federal estate tax exemptions and avoid losing any assets to estate taxes, providing the surviving spouse and ultimately the beneficiaries with the money and assets that the deceased set aside for them. The team at Evolution Tax and Legal is breaking down the AB trust: what it is, how it works and how it may benefit you.

How Does an AB Trust Work?

An AB trust is a form of irrevocable trust that can be set up by spouses to avoid the potential for a costly estate tax payout for couples whose estate is valued at greater than the federal exemption amount. The AB trust comes in two parts:

Part I: Marital Trust

The first part of the AB trust is a marital trust, which is created when the first spouse has passed. The marital trust can be handled as part of the will or as part of a living trust. The deceased’s share of any community property and separate property is to be transferred into this marital trust, and it will be used to benefit the surviving spouse. No estate tax will be owed on the amount within the trust at the death of the first spouse. The surviving spouse does not technically own the property that is deposited into this trust, their use of these assets and property is secured within the trust agreement and is dependent on the spouse’s cooperation with the rules of the trust. The main purpose of the marital trust is to benefit the surviving spouse and name the beneficiaries who will receive the assets that are held within the trust at the time of the second spouse’s passing.

Part II: Bypass Trust

Once the second spouse has become deceased, the second part of the AB trust will kick in, which is the Bypass Trust. All of the property within the marital trust will be transferred into the bypass trust at this point, and distributed to the named beneficiaries Typically, these beneficiaries will be the couple’s children. The legal system allows the second spouse to use the estate tax exemption once again, to transfer the couple’s assets up to $12.06 million in value without any estate tax being paid.

AB Trust Advantages

Due to the portability tax provisions, put into place in 2011, that allow surviving spouses to use any remaining exemption amount not used by their deceased spouse to avoid paying estate taxes, AB trusts are often not necessary. However, AB trusts can be very advantageous for certain individuals when it comes to estate planning. If you and your partner are not legally married, you will be unable to take advantage of the portability tax provisions, so you will not be able to access any unused exemption amount your partner did not use. As such, an AB trust can help you access tax optimization benefits without the portability provisions. If you want to ensure that your children receive the property you intended for them, an AB trust is a great way to do so. The second part of the trust, the bypass trust, will ensure that your assets are being distributed to the beneficiaries you named at the creation of the trust. If you live in one of the 12 states that still collects state estate taxes, an AB trust can also help you optimize tax benefits. The state exemption amount is generally lower than the federal amount, and does not have a portability provision in place, so using an AB trust can help you avoid excess estate taxation.

AB Trust Disadvantages

While they can be beneficial, there are also some drawbacks of AB trusts that are worth noting:

  • The Cost: When one spouse becomes deceased, the surviving spouse must hire an Orange County trust attorney or an accountant to work with in order to decide how to split the deceased spouse’s assets among the irrevocable trust and the surviving spouse’s living trust. This division can have important implications for taxes.
  • The Process: The surviving spouse will be responsible for record keeping when it comes to keeping track of all activity relating to the irrevocable trust. They will also need to get a separate tax identification number for the trust, and file a tax return each year.
  • The Restrictions: The surviving spouse has access to the irrevocable trust, but due to the nature of the trust there will still be restrictions on how they are able to use the property within the trust.

AB Trusts and Estate Tax

AB trusts were originally created as a method to help couples avoid paying costly federal estate taxes after a partner died. It allows this state tax avoidance because it passes through the irrevocable trust and is never directly owned by the surviving spouse. While this can still benefit some couples, as we mentioned the changing of tax laws and the portability provision have made changes that make AB trusts irrelevant to some couples.

AB Trust Frequently Asked Questions

Is an AB Trust Irrevocable?

An AB trust is considered a revocable trust when it is created, as long as both spouses are alive. Once the first spouse becomes deceased, part of the couple’s assets are put into a revocable living trust for the surviving spouse, and part of the assets are put into the irrevocable trust on behalf of the deceased spouse. The A portion of the trust is revocable, and the B portion is the irrevocable portion of the trust.

What Is the Difference Between a Marital Trust and a Bypass Trust?

The marital trust is a different name for the revocable living trust that is held by the surviving spouse. The bypass trust is another name for the irrevocable trust that assets are placed into on behalf of the deceased. The bypass trust is sometimes referred to as the family trust or a credit shelter trust.

Are AB Trusts Obsolete?

While AB trusts are not as helpful as they once were, due to changes in tax laws, they are not obsolete. As we mentioned in the advantages above, there are certain individuals who will continue to benefit from an AB trust to protect their estate from taxation once they have passed.

Do You Need an AB Trust? Evolution Tax and Legal Can Help

If you are a couple that thinks you may benefit from an AB trust, the team at Evolution Tax and Legal can help. We have the expertise and personalized care to work with you to come up with the best plan to optimize your estate tax benefits in the future. Contact our team today to learn more.

June 17, 2022

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